FHA Mortgage

A mortgage on which the lender is insured against loss by the Federal Housing Administration, with the borrower paying the mortgage insurance premium.

What FHA Does: By insuring lenders against loss in the event that borrowers default on their loans, FHA encourages lenders to make loans that they might otherwise view as too risky.

FHAbegan operations in the depths of the depression of the 1930s when lenders had stopped making new loans altogether because a sizeable proportion of existing loans were in default. As the country worked its way out of the depression, the FHA settled into the principal role it has today: helping a segment of the low-and-moderate-income population become homeowners who otherwise might not make it because they have shaky credit, or can't come up with the cash needed for the down payment.

Some FHA programs are subsidized. For example, a special program of mortgage insurance for members of the armed forces is subsidized by the armed forces, while special programs for older declining urban areas and for displaced households are partially subsidized by FHA through insurance premiums that don't cover losses. Its standard (Section 203b) program, however, was designed from the beginning to be self-supporting out of the insurance premiums paid by borrowers. When during the late 80s rising defaults eroded the reserves that FHA maintains to pay losses under this program, the insurance premiums were raised substantially to restore the reserves to an adequate level.

FHAloans are subject to size limits, which vary from state to state and county to county. In 2003, the basic limit was $154,896 but it ranged up to $280,749 in high-cost areas. The limits by state and county are raised every year and can be found at https://entp.hud. gov/idapp/html/hicostlook.cfm.

Who Should Take an FHA? FHA loans are for borrowers who can't meet a 5% down payment requirement and have poor credit. Borrowers who can put 10% or more down and have good credit will do better with a conventional loan. The best loan type for borrowers who fall in the middle depends on the specifics of the case.

The great appeal of the FHA program is that it allows 1% down. Private mortgage insurers, in contrast, require 5% down on most loans and only allow 3% down on special programs. FHA is also liberal in allowing gifts to be used for paying settlement costs. SeeDown Payment/Home Seller Contributions.

FHAborrowers may also have weaker credit than private insurers accept. FHA allows higher ratios of expense to income, is more tolerant of existing debt and will allow the income of co-borrowers who don't live in the house to count fully in measuring income adequacy. It is also quite forgiving about bad credit. For example, a borrower need be out of a Chapter 7 bankruptcy for only two years and out of a Chapter 13 bankruptcy for only one year.

FHA loans are generally available in the market at about the same interest rate and points as conventional loans with the same term. There may be a difference in mortgage insurance premiums, however.

On an FHA 30-year fixed-rate mortgage (FRM), the mortgage insurance premium in 2003 was 1.5% of the loan amount paid up front plus .5% of the loan balance paid monthly. The premium is the same regardless of the down payment.

On conventional loans, the insurance premium depends on the down payment. With 5% down, the premium on a 30-year FRM is about the same as on an FHA. With 10% or more down, the premium on conventional loans is lower.

Borrowers who are unable to make a down payment but have strong credit have another option. Conventional loans are available with no down payment and no mortgage insurance, but borrowers pay a higher interest rate. Cash-poor borrowers with good credit should explore this alternative to an FHA. Veterans also have the option of a VA-guaranteed loan. SeeVA Loans.

Some loan officers steer borrowers into FHA loans who would do better with conventional loans. Either they specialize in FHAs and don't want to lose a sale, or they can earn a higher fee on an FHA, or both. If you can put 5% down, or you have good credit (a FICO score of, say, 700 or higher), don't let anyone steer you to an FHA without considering alternatives.

FHA Loans Are Assumable: Both FHA and VA loans have the advantage that they can be assumed by a qualified buyer. If a house is to be sold with an FHA or VA mortgage carrying a rate well below the current market, the seller can enhance its marketability by allowing the buyer to assume the old mortgage. Conventional loans carry due-on-sale clauses that require the loan to be repaid when the house is sold. SeeAssumable Mortgage.

FHA and House Quality: Homebuyers often assume that FHA's involvement as the mortgage insurer protects them against defects in the house. It doesn't. FHA has been bedeviled by this problem since it began operations in 1934.

The assumption that FHA protects the homebuyer is reasonable. FHA requires a property appraisal and that homes meet certain “minimum property requirements.” In 1999, furthermore, FHA adopted a new set of rules regarding appraisals that it trumpeted in PR releases as a Homebuyer Protection Plan. The fact is, however, that FHA does not guarantee the value or condition of a home. FHA appraisals are to protect FHA, and homebuyers should protect themselves by ordering a home inspection.

In 2000, FHA developed a form that all purchasers of existing houses taking an FHA mortgage must sign before the date of the sales contract. The form is entitled: “For Your Protection: Get a Home Inspection.” Immediately above the signature, it reads:

I understand the importance of getting an independent home inspection. I have thought about this before I signed a contract with the seller for a home.

By electing the Mortgagee Optional Election Assignment, lenders will be permitted to modify their FHA mortgage insurance contracts to permit assignment of an eligible HECM to HUD despite the HECM being eligible to be called due and payable as a result of the death of the last surviving borrower.

FHA mortgage loans are limited to a certain size, however, making them unavailable to families living in high-cost housing areas Homebuyers unable to secure a conventional loan or an FHA loan often turn to subprime adjustable-rate mortgages (ARMs).

Amazingly, despite the fact that borrowers with tax debt carry foreclosure risk "two to three times" greater than those without unpaid taxes, applicants for FHA mortgage insurance are not required to provide their federal debt status to FHA, and such information cannot be obtained without taxpayer consent.

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